Search for profits and business fluctuations: How does banks’ behaviour explain cycles?

Abstract

This paper develops and estimates a macroeconomic model of real-financial markets interactions in which the behaviour of banks generates endogenous business cycles. We do so in the context of a computational agent-based framework, where the channelling of funds from depositors to investors occurring through intermediaries is affected by information and matching frictions. Since banks compete in both deposit and credit markets, the whole dynamic is driven by endogenous fluctuations in their profits. In particular, we assume that intermediaries adopt a simple learning process, which consists of copying the strategy of the most profitable competitors while setting their interest rates. Accordingly, the emergence of strategic complementarity in the behaviour of banks – mainly due to the accumulation of information capital – leads to periods of sustained growth followed by sharp recessions in the simulated economy.